Coffee Break 09.06.2017

Recent international gatherings proved that consensus among world leaders has become more difficult to reach, which does not help in easing geopolitical tensions. Meanwhile, continental European leaders are likely to embrace a stronger European integration in order to face the new realities following the regime changes in the US and the UK. After the elections in major European countries, a possible early election in Italy could ultimately clear the horizon and give time to the biggest countries to formulate a genuine European agenda. Building a roadmap including a strengthening of the single market, the financial sector and the crisis response complemented with an enforcement of external borders and an investment stimulus could lead to new dynamics in the EU, which should support domestic, small and mid-cap equities. In this context, we keep our overweight on euro zone equities. From a global perspective, we nevertheless maintain our tactical neutral exposure on equities, as we are looking for a better entry point in this current low volatility regime.

This week, we will closely monitor the ECB meeting, the UK general elections and the first round of French parliamentary elections.

Our current investment strategy on traditional funds:

Legend
grey : no change
blue : change

EQUITIES VERSUS BONDS

We are tactically neutral on equities and remain negative on bonds, maintaining a short duration:

• Global expansion dynamics are less uniform than at the turn of the year. The positive economic news flow has reversed in the US and economic surprises are negative. US equities are unimpressed, marking new record highs. The European recovery is well on track and should lead to above-trend growth in 2017-18, leading us to raise profit expectations. We think that the euro zone and emerging economies are best placed to leverage on these dynamics.
• Central banks dovishness to recede very gradually:
  • The ECB left its monetary policy unchanged, making no changes to its key interest rates or bond buying programme. However, QE tapering should become a central theme after the summer.
  • The probability of a Fed hike in June is now priced at 90%, with another hike expected later this year. The next step in the Fed tightening will be through balance sheet reduction, timing and size are however uncertain.
  • Tightening in developed markets is at odds with monetary policy easing in emerging markets, including Brazil.
• Equities have an attractive relative valuation compared to credit, and their expected return should be boosted by the end of the earnings recession in the US and Europe.
• Oil markets continue their rebalancing. However, while OPEC members are bringing back oil production to more durable levels, US rigs have been re-opening, implying a higher production and more time to absorb record inventories.
• Political risk has switched from Europe to the US. We think that we are past the peak of euro zone policy uncertainties, as the Italian risk on the horizon appears manageable. The geopolitical tensions in Syria and North Korea, the slippage in the timing of the fiscal stimulus due to the lack of political success in Congress and escalation of sensitive issues question the credibility of the Trump presidency.

REGIONAL EQUITY STRATEGY

• We remain overweight on euro zone equities. The French election outcome led to a sharp decline in the political risk premium. An on-going, more robust and geographically broadening economic expansion, an accommodative central bank (for now) and a strong corporate earnings momentum underpin the attractiveness of the region’s risky assets. Furthermore, relative valuations are attractive and non-resident flows are picking up gradually.
• We are underweight on Europe ex-EMU equities. The uncertainties of Brexit conditions and their impact on the economy lead us to avoid the region. While the bulk of the exchange rate adjustment might be behind us, we expect the earnings growth expectations to soften somewhat once the negotiation talks start in earnest.
• We keep our neutral stance on US equities. The US cyclical recovery stalled in Q1 and activity data has yet to catch up with survey optimism. Donald Trump’s unpredictability adds to the uncertainty. Reflation trade positioning has reversed back to early-November levels. Deflation dynamics no longer at work but we see a gradual rise. We identify an execution risk (at least a delay into 2018) in the expected fiscal stimulus.
• We have a neutral exposure to Japanese equities. Stronger global growth and a supportive domestic policy mix are among the main performance drivers, but a weaker currency is warranted to gain more conviction.
• We hold an overweight on emerging market equities, with India as our preferred market. They benefit from attractive valuations in a robust global growth context. China should not trigger a systemic risk this year, but we keep an eye on the impact of regulatory tightenings, which, have accelerated.

BOND STRATEGY

• We maintain our underweight on bonds and increase our short duration. With a hawkish Fed and continuing inflationary pressures, we expect rates and bond yields to maintain their uptrend. The improvement in the European economy could also lead euro zone yields higher as political risks recede and the ECB should start detailing its tapering to the second semester.
• We continue to diversify out of low/negative yielding government bonds:
  • We have a neutral view on credit, as spreads have already tightened significantly and a potential increase in bond yields could hurt performance.
  • We remain positive on inflation-linked bonds as we expect a rise in core inflation by fiscal easing, higher wages, less deflationary pressure in China. Potential US protectionist measures are a wild card.
  • We hold half of our relative value strategy: long German Bund / short French OAT as a hedge against the European political risk ahead of the June elections.
  • We have a slight overweight in emerging market debt, both in local and in hard currency terms. Emerging market bonds benefit from strong fundamentals as risks in China and a commodity rout have declined. Also, contagion from Brazil to the rest of the emerging markets has been contained. While fiscal consolidation reform and the growth recovery in Brazil are likely to slow down, we don’t believe that monetary policy easing is over.
  • We are close to a neutral high yield exposure. The spread compression has exceeded our targets on both sides of the Atlantic, but the carry remains attractive. On the currency side, we keep an exposure to the NOK to benefit from oil prices evolution. We hold a lower underweight on GBP ahead of the upcoming British elections.

• In the US, the ISM manufacturing came in at 54.9, slightly up from the prior level of 54.8 and still firmly above 50, the level that divides growth from contraction.
• At 138.000, non-farm payrolls came short of the expected 178.000. Revised payrolls from April came in at 174.000.
• In the euro zone, the Markit manufacturing PMI rose to 57 in May, its highest level since April 2011. Manufacturing activity surged, largely thanks to increase in new orders.
• Economic confidence unexpectedly dropped to 109.2 in May from a revised 109.7 in April and lower than the consensus estimate of 110. The reading was dragged down by weaker services and retail sectors. Confidence remains nevertheless at a high level. 

EUROPE

Positive week for European equities.

• Britain’s FTSE 100 and Germany’s DAX reached new highs as investors came back to European markets.
• 10th consecutive week of inflows for European equities according to data from Bank of America Merrill Lynch.
• Major winners were cyclical stocks while energy stocks lagged.
• News that Italy logged better-than-expected economic growth data lifted local shares.

US

Positive week for US equities.

• Major indexes (DJA, S&P 500 & Nasdaq) saw new high last week.
• Small caps remained below the records they established earlier in the year.
• Thursday’s report of a larger-than-expected drawdown in US oil reserves caused a short-lived bounce in energy shares.
• Jobs data also appeared to drive a rise in the markets late in the week.

EMERGING MARKETS

Slightly negative week for emerging equities.

• A sense of calm returned to the markets last week. Although political developments, notably in Brazil and South Africa, continued to inject some volatility, flows into emerging markets have been largely undeterred.
• Several Asian markets traded at or around multiyear highs.
• South Korea added 1.2% while Taiwan saw its best level since early 2000 and Hong Kong was at its highest since July 2015.
• Mexico’s central bank revised up its 2017 growth forecast, even so the local equity market lost around 1% over the week. 

RATES

Core European markets eased following the release of the latest macroeconomic data.

• Italian and Spanish bond markets suffered over the week on reports that Mateo Renzi could seek early elections. The Italian spread versus Germany rose to 192bps.
• By contrast, core markets eased following the latest inflation print (at 1.4% YoY vs. 1.5% expected).
• The rally accelerated after the release of mixed US labour data and the US Treasuries yields dropped to 2.17 following below forecast NFP figures.
• 10Y US, UK, Japan and German yields stood at respectively 2.17%, 1.04%, 0.04% and 0.28%. 

CREDIT

Widening of Italian spreads at the beginning of the week on the back of early election concerns.

• Comments from Mario Draghi, on low inflation implying an ECB support for a longer time, gave some relief for credit market.
• The first round of the auction of Banco Popular has been extended to the end of the month, which is a big concern as the bank is running out of time and the conditions for a capital increase are not met (AT1 close to 50 cents).
• Globally, stable cash market spread (BoA ML € Credit at 110bp).
• We observed a supply increase despite the Monday bank holiday in the UK. 

FOREX

Oil/Commodities currencies were hit by the disappointing OPEC meeting.

• The AUD and the NOK were the main penalised currencies following the OPEC meeting.
• The EUR was one of the main performer of the week as economic outlook remained positive in the region.
• The GBP was unable to benefit from the USD’s retreat as the local general elections are approaching.

COMMODITIES

Concerns over growing US supply dominated oil markets.

• Brent crude slid under $50 a barrel last Friday and was heading for a second consecutive week of losses.
• US output rose to 9.3m b/d according to weekly data, the highest level since August 2015.
• The US withdrawal from the Paris climate agreement did not help sentiment either, as it raised concerns that US production could accelerate even more sharply. 

WEEKLY MARKET OVERVIEW

UPCOMING FACTS AND FIGURES